Friday, October 26, 2012

Bah, Humbug

This morning's GDP release appears favorable until you get into the details and realize that there was a big rise in federal spending. The private economy is flat as a pancake, exemplified by real Gross Private Domestic Investment (GPDI), which is just slightly above zero now for two quarters (3.3 billion and 2.5 billion). If you go to Table 3, you'll see that the net real quarterly SA gain was 67.7 billion compared to Q2's 42.1 billion. Which is nice, until you slide down to the next page and find that whereas government spending decreased by 4.3 billion in Q2, it increased by 22.4 billion in Q3, for a net swing of +26.7 billion on government spending. Taking off our footwear and thus doubling our calculation power, we find that 67.7 billion - 26.7 billion = 41 billion. Thus, we have a private economy running in place at a very low level, below +1.5% annualized. This takes us to the dreaded stall zone, with some hope that Q4 will bling us up out of that zone.

Well, it is the end of the fiscal year, and government agencies do reliably spend their allocations. Still, if you want to think conspiracy theories, imagine an executive issuing orders to "spend that money now", and go to town. 2013 looks to be very difficult indeed. We really do need to increase payroll taxes, but it's obvious that this will be a drag on PCE without price drops. There's nothing favorable going on in the global economy to help us out.

Possibly a change in the administration will provide some hope for companies and inject a little more confidence into the private economy. Business spending is terribly weak. Real nonresidential GPDI fell at a -4.7 billion pace this quarter compared to a +12.9 billion pace in Q2. You can't expect a huge growth in consumer spending without a tax cut or massive price decreases, because some indicators of consumer stress are already rising. For example, delinquency rates on residential mortgages have risen from a post-debacle low of 10.15% to 10.61% in Q2, and new regulations which should tighten residential mortgage lending are due to go into effect next year. Subprime auto loans are beginning to weaken. It looks like we may have reached the limits there, barring real economic improvement. Rail and inland water freight indicators show growing YoY weakness.I always thought that as soon as autos stopped bailing us out this year we'd tip over. According to BEA, auto output accounted for a -0.47% change in Q3 real GDP. On this release, which is preliminary, I expected a slightly lower headline (1.8%) but better underlying details for the private economy, so I am disappointed.

It would help, too, to get the threat of sequestration out of the way. Because of the cost-plus structure of the single-customer market, the defense industry really lives hand-to-mouth (I've been involved in the budgeting process for internally-funded R&D, and it's always on a shoestring basis). A cut in that budget translates to massive job losses the next day.

The really damaging part about sequestration is that there's no smarts to it. Just an across-the-board cut. Honestly, I think some budget cuts might do procurement some good--make them think hard about what they really need. But if it's just across the board, they can't be smart about it.

What's so disastrous about the F-35? It's behind schedule and over-budget, true. But they're going to make many thousands of them in the end, because the F-16 fleet is reaching end-of-life the world over.

Besides, so many other countries have put so much money into the project that it would create an international incident to cancel the program now.

“Still, if you want to think conspiracy theories, imagine an executive issuing orders to "spend that money now", and go to town.”

It is not a conspiracy theory. My client and friend in the defense industry said all the prime contractors were told to speed up their deliveries. He initially thought it was because something big was coming such as an attack on Iran’s nuclear facility. I disagree that that is imminent. I believe it was simply Obama trying to shore up the GDP number for his election.

Conspiracy? Naw. If a man is willing to expend the lives of an ambassador and others for the sake of his smart diplomacy narrative, such man is capable of anything.